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China musings

Let’s put the falls in the Chinese equity market into context.

Chinese equity market in contextOld Mutual Global Investors

  • Rather than looking emotively at the sharp falls in China’s equity market it’s important to put the current volatility in historical context. 
  • Using the price to book ratio, Asia is at its lowest point since the onset of the financial crisis, although it’s still 20% higher than the lows of 2008.
  • By contrast, the US is 28% off its 2011 lows and 40% off its 2008 lows.
  • Even if you assume the newsflow is going to be as bad as 2008, the downside, we believe, is becoming more limited in Asia, especially in light of the recent currency moves.

Currency devaluation

  • Two of the most popular reasons for China’s motives on devaluation are whether or not it’s in response to the country’s growth slowdown or whether it’s in response to the IMF’s requirements for entry into the SDR (Special Drawing Rights). We’re unlikely to know the real reason.
  • However, looking at a basket of major currency moves against the US dollar – the euro, yen and Australian dollar – it’s clear that the yuan has appreciated the most against the greenback over a period of 10 years.

Policy response

  • China has significant foreign reserves and a policy interest rate of 4.85% as opposed to zero in the US, Europe and Japan. India’s interest rate is 7.25%. Fiscal and/or monetary response from the authorities could therefore occur and is less likely factored into the ‘uncertainty’ given current valuations in Asia.

Fund positioning

  • Volatility is unsettling and recently we have increased our cash levels in the fund. However, we are looking to take advantage of this recent sell-off as many companies are starting to look oversold. The main risk to this strategy would be a fall in US markets where the valuation ‘buffer’ is much lower than Asia.

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The views expressed by external contributors are not necessarily those of Old Mutual Wealth or Old Mutual International.

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